| Breakeven Inflation |
The rate of inflation that the market expects will equate the returns on inflation-linked bond and a 'comparator' nominal bond issue of the same term. The market shortcut is to subtract the real yield from the nominal yield:
Breakeven Inflation = Nominal Yield - Real Yield
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| Breakeven Inflation Curve |
A line that joins the different breakeven inflation rates (plotted on the y-axis) with the corresponding maturity (plotted on the x-axis). |
| Breakeven Spread |
Breakeven spread or the breakeven inflation spread is the difference between the breakeven inflation at two points in time.
Breakeven Spread = Breakeven Inflation at time 't' - Breakeven Inflation at time 't-n' (where n is any positive rational number) |
| Carry |
The net financial cost is more commonly called the 'cost of carry' or carry. It adjusts the financing rate for the coupon interest earned.
Carry = Yield - Financing Rate
Positive carry means that the yield earned is greater than the financing cost and negative carry means that the financing cost exceeds the current yield. |
| Core Inflation |
Core inflation or underlying inflation is that part of inflation that is obtained by stripping out unwanted or excessively volatile elements of headline inflation. A necessary drawback of suck a measure is that it is not theoretical and based more on statistical procedures. For instance the U.S. core inflation excludes energy and food from the headline inflation. The Bloomberg ticker for it is:
U.S. Core Inflation: CPUPXCHG Index |
| Flat Index Ratio |
Determines how much inflation has increased or decreased between the issuance date and the last coupon date. The ratio is calculated by comparing the CPI of the last coupon date to the base CPI value at issuance:
Flat Index Ratio = CPI of the last coupon date / Base CPI value |
| Forward Curve |
An interest rate curve derived point by point from the traditional yield curve. The forward curve shows the implied forward interest rate (the interest rate for a specific forward period calculated from the incremental period return in adjacent instruments on the spot zero coupon yield curve) for each period covered by the yield curve. The forward curve is used to price many interest rate derivative instruments. |
| Headline Inflation |
A measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. The following are the headline inflation indices for the leading inflation-indexed bonds issuing counties:
U.K.: Seasonally Adjusted Retail Price Index
U.S.: Seasonally Adjusted Consumer Price Index—Urban, U.S. City Average, All Items |
| Index Ratio |
Shows us how much inflation or deflation has occurred between the issuance date and the settlement date. The ratio is calculated by comparing the reference CPI to ? |
| Inflation Accrual |
An adjustment to the principal value of a bond to reflect the amount of inflation from the last coupon date to the settlement date. This is done by adjusting the market price by the accrued ratio growth (accrued ratio growth is the difference between the index ratio and the flat index ratio).
Inflation Accrual = Accrued Ratio Growth x Market Price |
| Inflation Carry |
Inflation carry is defined similar to 'carry'; however, the yield in carry is substituted by the real yield added to current inflation.
Inflation Carry = (Real Yield + Current Inflation) - Financing Rate |
| Leveraged TIPS |
TIPS issues financed typically via reverse repo. TIPS are used as collateral for borrowing, and then reinvested in additional TIPS. |
| NSA CPI |
(Non-Seasonally Adjusted U.S. City Average All Items Consumer Price Index for all Urban Consumers) This is the federal government's widely known inflation measure, used to adjust principal and interest payments of U.S. inflation-linked bonds. This is maintained by the Bureau of Labor Statistics. This index can be seen at www.bls.gov/cpi/. |
| Nominal Interest Rates |
Interest is the price you pay (receive) for borrowing (lending) money. Assuming no credit risk is involved, Nominal interest rates reflect real rates plus an inflation risk premium. |
| Real Yield |
The price of money you receive for giving-up consumption today in order to consume in the future. This is equal to the nominal yield minus inflation adjustment:
Real Yield = Nominal Yield - Inflation
Inflation-indexed bonds reflect real yields, a liquidity premium and the price investors are willing to pay for inflation insurance. |
| Reference Index |
The inflation-indexed 10 year note reference CPI level. The CPI number that is calculated when valuing inflation-indexed bonds is based on a 3 month lag. As CPI is calculated and released only once per month and that CPI number is always dated 1st of the month, so we have to interpolate the CPI number. The reference index value is calculated the following way.
M = Current Month
N = Total number of days in each month M (i.e. 31 days in May)
D = Number of days from 1st of month to current day |